Islamic Banking in Malaysia: Unchartered Waters Mohamed ARIFF† and Saiful Azhar ROSLY International Center for Education in Islamic Finance (INCEIF) This paper explores the Islamic banking business in Malaysia since its beginning in 1983. The Islamic banking sector has achieved its target of 20% market share in assets and deposits in 2010. To boost the industry’s competitiveness and efficiency, the demands of the market forces will have to be delicately balanced with the dictates of the Shari’ah. The search for niche Islamic banking products warrants enhancements in the current regulatory, legal, and fiscal infrastructure for Islamic banking, without which these products cannot be a viable alternative to the conventional ones. While the prevailing infrastructure is conducive to Islamic banking products that hold similar characteristics with interest-bearing loans, Shari’ah compliance can be a futile exercise when the purpose of the law (maqasid al-shari’ah) is overlooked, for there is much more to Islamic banking than the elimination of interest. Key words: conventional banking, interest free, Islamic banking, profit sharing JEL code: G21 1. Introduction Islamic finance is now a big industry worldwide. There are over 100 Islamic banks spread across 35 countries, excluding those in Pakistan, Iran, and Sudan. The Islamic finance industry is currently estimated to be worth about US$1 trillion, having grown at an annual rate of about 14% during the last 15 years (Sarif, 2011). While Islamic banking is fully in place in Iran and Sudan, it is making significant inroads elsewhere, covertly challenging the well-established conventional system. In Kuwait and Qatar, Islamic banking accounts for over one fifth of total deposits. Bahrain has emerged as a major Islamic financial center that provides Islamic instruments for money management. Meanwhile, a market for Islamic securities has emerged in Malaysia. What is more, many big names in multinational banking – which include Chase Manhat- tan, Citibank, ABN Amro, and HSBC – are now offering Islamic financial products. HSBC’s Amanah Finance, set up in 1998, was initially targeting its clientele in Saudi Arabia and Malaysia, but is now going global by reaching out to North America, Europe, and Australia. Islamic banking is not confined to full-blown Islamic banks only, as conventional banks also offer Islamic financial products through Islamic windows. Ironical as it may sound, conventional banks have given Islamic finance a greater outreach through their extensive branch networks than Islamic banks themselves. This is indeed the case in †Correspondence: Mohamed Ariff, INCEIF, Menara Tun Razak, Jalan Raja Laut, 50350 Kuala Lumpur, Malaysia. Email: mohdariff19@gmail.com doi: 10.1111/j.1748-3131.2011.01208.x Asian Economic Policy Review (2011) 6, 301–319 © 2011 The Authors Asian Economic Policy Review © 2011 Japan Center for Economic Research 301